Pay off my mortgage or invest in another property?
Paying off your mortgage early is always wise, but taking on more debt to buy an investment property can be lucrative too. Let's look at the pros and cons of both strategies.
Paying off your home loan faster makes sense. The faster you pay off your mortgage the less you will pay in interest.
But you could also take on more debt and buy an investment property. This is obviously a very big and risky decision, but if done correctly it could set you up with an investment that improves your financial position.
Let's examine both options in detail.
Pay off your home loan faster and get out of debt
Reducing your mortgage debt is always a good idea. If you had a $500,000 mortgage over 30 years with a 4% interest rate, you'd end up paying $359,347 in interest on top of that.
If you were 10 years into that mortgage and you started paying an extra $200 a month in repayments you'd end the home loan two years and three months faster. Plus you'd pay $22,000 less in interest.
The benefits to paying off your mortgage faster are obvious:
- You can save more of your hard-earned cash.
- Being debt-free means less worry about repayments and more financial freedom.
- Your property is a form of wealth: the less debt you hold, the more equity you'll have.
Buy an investment property
But not all debt is bad debt. If you're borrowing more money to invest in an income-producing and wealth-creating asset, such as an investment property, that's a pretty productive debt.
Buying an investment property rather than paying off your home loan allows you to produce rental income, enjoy tax benefits from negative gearing and eventually see a capital gain from the sale of the property. In this light, taking on extra debt doesn't seem unreasonable.
And while paying off your mortgage faster makes financial sense, the greater benefits come from doing this early in the loan, not later. This is because of compound interest. Early repayments at the start of a 30-year loan are far more effective in cutting down interest than extra repayments made 20 years into the loan.
Property investor tax benefits
When you're paying off the mortgage on your home you can't deduct your interest payments from your tax. But you can with an investment property. In other words, the interest you pay on your investment mortgage can help reduce your tax bill.
For this reason, many investors focus on shrinking the mortgage on their home first: that debt has no tax benefits.
Get more tax tips for property investors.
But can you handle an investment property?
So, as we've seen above, there's no right or wrong answer. Getting out of debt is always a good idea, and buying an investment property later in your mortgage is a strong option too.
It all depends on what you can handle. "The decision to invest in another property when you already have a home loan is a pretty big decision because you're taking on more debt," says Financial Spectrum managing director Brenton Tong. "Probably the most important consideration of your financial position at the time is your cash flow.
"You can have an enormous amount of equity in your property and you could almost have your property paid off, but if you don't have the available cash flow to fund additional debt then you're going to be putting yourself in harm's way. If, on the other hand, your debt is quite high and your equity is quite small yet you still have an abundance of cash flow, then quite possibly you might be in a position where you can get into property investment much earlier than you think you can."
The bottom line: don't buy an investment property if you don't have the cash flow to cover the repayments and property maintenance. Obviously having a rent-paying tenant reduces the money required, but you need to anticipate higher costs, property damage and periods without a tenant.
The risks of investing in property
Property investment is never a certainty (no investment is). Here are some risks to be aware of:
- Being a landlord is work. You have legal responsibilities to maintain your investment property so your tenants can live in it. This can be costly.
- A property can lose value. There's no guarantee that the property you buy will grow in value year over year. You need to do your research and buy a good property in a good location.
- You might not find a tenant. Untenanted periods mean months without rental income and that can make your investment very expensive.
Other investment options
Mortgage repayments and property investments certainly aren't your only options. Here are some more possibilities for home owners with extra cash on hand:
- Put more money into an offset account. If you mortgage has an offset account you can put extra repayments here. It mimics the effect of extra repayments but you can pull the money back out to spend on an investment or anything else. It gives you greater flexibility.
- Add to your super. Putting more money into your super fund can set you up for a comfortable retirement.
- Make smaller investments in shares or ETFs. Investing in shares or products like exchange-traded funds (ETFs) lets you put your money to work without the massive commitment of purchasing an investment property.
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